In October last year, the Bank of England (BoE) wrote to all UK banks asking how ready they would be should the current BoE base rate moved into negative territory.
While the subject remains hypothetical, it has raised questions over how such a move could impact both individuals and businesses from a borrowing and cash deposit perspective.
Lowering interest rates is a tactic employed by central banks to encourage spending when economic growth is weak. Because of the significant impact of the pandemic, and interest rates already being so low in the UK following weak growth post the 2008 financial crisis, attention has turned to how the BoE can keep money in the real economy and kick-start spending again. While quantitative easing is one option, so too is a further interest rate cut – either way, the intention would be to get money flowing out of banks and into the economy in the form of loans and mortgages.
With interest rates currently sat at 0.10%, any move to cut the rates further could lead to them falling below zero, something that is not as uncommon as we might think. In June 2014, the European Central Bank deployed negative interest rates, as did Japan in 2016. However, past evidence suggests this has not always necessarily encouraged the lending levels the move was designed to trigger. Why?
If banks are charged for holding cash reserves, rather than being paid, then they would need to recoup their profits in other ways – banks should ideally pass on the cost to savers but have historically been reluctant to do so, choosing instead to increase banking charges or fees. If they cannot do this, they could choose to reduce lending altogether, which would have an adverse effect on those wishing to borrow, which is what the government wants to happen to boost the economy.
While a similar move in the UK would, in theory, encourage borrowing and discourage deposits and savings, there are other interesting implications on how this could affect businesses, savers and mortgage holders.
In a situation where a mortgage comes with a negative interest rate, the lender would have to pay the borrower, meaning you would end up paying back less than you borrowed. If this were to happen, the lender would not make a monthly payment to the borrower; instead, they would reduce the outstanding capital, thereby decreasing the time it takes for the borrower to repay the debt.
In reality, if rates went below zero, most UK mortgages are either fixed at a rate above zero or are tracker mortgages that have a mechanism in place which prevents them from dropping below a certain positive percentage level, meaning very few borrowers would actually experience a reduction in their loan amount.
As we have experienced, low interest rates do little to boost our savings and negative rates would effectively take that further by penalising customers and businesses for keeping their savings in their bank account, as the value would decrease over time. To avoid this, customers could withdraw all their cash from their accounts but, not only is this risky, it also reduces the liquidity of banks and their ability to lend meaning penalising savers is in neither party’s interest. Ultimately, while banks would not pay out any interest to customers who have a 0% rate on their savings account, in the main, customers would not have to pay the bank to hold onto their money for them.
One method, which sounds simple in practice, is to constantly review what interest rate your accounts are offering and move your money where the better rates are. However, in many instances, this is impractical due to the hassle involved in opening one new account, let alone several, and often proves to be an administrative burden and too time consuming.
An efficient solution is to employ the use of a cash management platform, which we do for many of our Clients at Finura. These platforms provide secure, online access to multiple banks and products, all through once centrally managed account with the cash management provider. As well as removing the administrative burden, they help ensure that your money is benefitting from the highest interest rates that are currently on offer. Another benefit is that by spreading your cash across multiple accounts, you can also fall inside the protection of the Financial Services Compensation Scheme, which covers you up to £85,000 per financial institution (not per account).
For more information, please contact your Finura adviser.
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